The Safe Withdrawal Rate

In my previous post, Meet the Plan, I mentioned that with $1,000,000 in investments, it would generate $40,000 a year with a 4% Safe Withdrawal Rate (SWR) or $30,000 a year if using a more conservative 3%? I had also mentioned briefly that the SWR’s chosen were based on the Trinity Study back in Meet SP.

Trinity Study

Well, back in 1998, a few finance professors at Trinity University in San Antonio, Texas (not the Trinity College in Dublin, Ireland) performed a study to determine the safest withdrawal percentage (or Safe Withdrawal Rate/SWR for short) for retirement portfolios. For the details, feel free to read the original paper.

The following assumptions were made:

The retirement period is only 30 years.

A static 4% is withdrawn yearly based on the initial amount of the portfolio and increased by inflation each year to fund yearly expenses.

The retiree will neither receive a pension or social security income.

With the following assumptions, the article concluded that “withdrawal rates of 3% and 4% are extremely unlikely to exhaust any portfolio of stocks and bonds”. Furthermore, the Trinity Study targeted a portfolio (75% of stocks and 25% of bonds) that will fail no more than 1% of the time after 30 years, assuming that the investor will never make any changes other than inflation adjustments. This means that the investor will always withdraw 4% of the original portfolio, even if there is an economic downturn, reducing their stock portfolio by half and were the main failures.

To simplify even more, the main source of failure in a portfolio generally happened if the retireee retired just before an economic downturn or collapse and still withdrew the static 4% on a reduced portfolio size.

3 or 4% Safe Withdrawal Rate

With the assumptions I made in my plan, a 7% annual return (10% annual increase – 3% inflation) would ensure the portfolio would last forever, whether it is a 3 or 4% SWR. However, if we take a look at FIRECalc (a useful tool for simulating how long your portfolio will last).

With spending at $40,000, a portfolio of $1,000,000, and 30 years, it has a success rate of 95%. When adjusted for 100 years, the portfolio will have a success rate of 72%.

Now what if we adjusted the spending from $40,000 to $30,000 to effectively reduce our 4% SWR to a more conservative 3%? With spending at $30,000, a portfolio of $1,000,000, and 30 years, it has a success rate of 100%. And finally, when adjusted for 100 years, the portfolio still had a success rate of 100%.

What does this exactly mean?

Well, in short, it is definitely easier to have a portfolio last long with a lower SWR. But by having a lower SWR, this will mean that we will need a larger investment portfolio.

Flexible Safe Withdrawal Rate

After the Trinity Study was published in 1998, a few more follow-up studies have been made and found that higher and lower SWRs are possible as long as the individual is willing to adapt to the changes of the market.

This means that if the stock market decreases a lot, we will adapt by reducing our spending for that year. And if the stock market increases by a large margin the next, we can readjust our spending for the increased amount of income generated (or keep spending the same amount and reinvest the extra).

Final Words

To put it simply, while we can follow the Safe Withdrawal Rates of the Trinity Study or any of the other follow-up studies. The easiest way to make sure your portfolio will never run out is to adapt your SWR to the market. While our income will fluctuate from year to year (or maybe none if you can maintain static spending and lower when necessary), as long as we cover the bills and readjust our earnings and losses for other years, this approach will probably be one of the simplest ones out there.

And as seen before on my Net Worth Reports, I currently spend a little less than the expected withdrawal rate of $30,000. As time goes by, I will be adjusting it up and down (hopefully down) to make sure my portfolio can withstand the tides and last for a very long time.

What do you think about this? Are there any assumptions I have missed? What withdrawal rates are you going to use when you quit your job?

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8 thoughts on “The Safe Withdrawal Rate”

4% withdrawal rate is relative safe. One point is that one should plan retirement and learn to invest as early as possible. Investment needs experience. Generally, after investing more than 10 years, investors will do not panic when the market goes down.

I agree with you, it’s definitely hard to stay calm when the market goes down. Most people tend to sell off all their holdings when they see the stock market drop and never invest again. That might also be where and how the stock market gets a bad rap.

I’ve read quite a few posts and articles about the 4% SWR. My plan is to try to use a 3% SWR (or less if I don’t need it that year) to add in the extra margin of safety. Also try to do some part time work that I enjoy even if I dont really need it for the money. Its always good to have that extra buffer/ spending money that can also defer any withdraws from your portfolio, especially if you are retiring early. I actually don’t mind working (and making some money) but I dont like committing 40 or 50 hours + commute time to it every week.

I’m still 20+ years off of retirement, but I too am also considering a more conservative 2-3% distribution of principal. I’d like to get in the neighborhood of 50% of expenses covered by dividends in those early years to protect against early drops. Especially if interest rates somehow manage to be this low for a prolonged time when I retire as well.

It would be awesome if you could get 50% of your expenses covered by dividends to protect against the early drops. It would be even more awesome if there were no early drops and the market kept growing. We can only hope for the best and not retire just before a crash.

I think depending on when you want to retire that if you are planning to reach retirement early that 3% probably would be safer and if you reach retirement later in life that 4% probably makes more sense. But then again depending on when the next recession I’d feel much safer with the 3% withdraw rate.